A Roth IRA has many advantages over a traditional IRA. The difference is that you make contributions to a Roth IRA with after-tax dollars. You cannot deduct them from your taxes, as you can with a traditional IRA, but when it comes time to making withdrawals, you will not have to pay taxes on your earnings. Because of this, the same amount contributed over the same amount of time in a Roth IRA may result in a better return on investment than the same amount placed in a traditional IRA.
Understanding the Problem
The problem that many find themselves in is that many employers have added a Roth IRA to their 401(k), 403(b) and government 457(b) retirement plans. With this feature, you can choose to designate a portion or all of your elective contributions to the Roth IRA. This amount must be taken out after taxes are withheld.
One of the issues that some have found themselves in is that the employer does not follow your instructions as to the type of deferral. Many times, this is because the employer uses older software that was developed before the IRS added this feature. The result is that the software treats it like a pre-tax deduction, as you would have if it were a traditional IRA.
Unfortunately, many do not discover this mistake until they file their taxes in the following year. For instance, you might have a 401(k) that has a Roth feature. You assume that your human resources department is taxing the contribution correctly. Your company discovers it when they are doing their W-2 forms in January of next year. This can leave you with a tax issue if you do not correct it.
Correcting the Mistake
If you find out that your Roth IRA contribution applied to the wrong year or that it was taken out pre-tax, the IRS provides an easy way to fix it and avoid penalties. Sometimes, your contribution is applied incorrectly if you converted from a traditional to a Roth IRA.
If your employer incorrectly deducted your contributions as pre-tax, they can transfer the deferrals that were incorrectly applied from the Roth account to an after-tax account. They will have to adjust the earnings to do this. Then, the company can issue a corrected W-2, and you can file an amended tax return for the year when the error occurred.
The above method is the easiest way to fix a minor error, but if the amounts are significant, the IRA has a voluntary correction program that allows the plan sponsor to correct it. Your employer is only eligible if they make the correction within two years of the error.
Change IRA Contribution Year
If, for instance, you made a contribution that you attributed to 2012, but it was actually in 2011, you can often withdraw the contribution or recharacterize it. The process has many rules, but in some cases, recharacterization will be allowed. Since the Roth IRA is not reported on the tax return, except form 8880, you have options. If you do not qualify for a contribution or do not want to make a contribution in 2012, you can have the contribution recharacterized as a traditional IRA contribution for 2012.
Can I change my IRA contribution year? When you schedule an IRA deposit, you sometimes have the option to specify the tax year for your contribution. If you find that your IRA contribution applied to the wrong year, many plan sponsors will allow you to change it, but only if the contribution was made before the deadline. Once the deadline has passed, then you cannot change it.
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.